Economics Prelims cum Mains

Key monetary tools at the RBI’s disposal

Why in News?

  • The Reserve Bank of India (RBI), earlier this month, raised its policy repo rate by 25 basis points to 6.25%, the central bank’s first interest rate increase in four-and-a-half years.

 

Key monetary tools of RBI

  1. Cash Reserve Ratio (CRR)
  • Banks need to hold some portion of their deposits in cash with the RBI. This ratio is called CRR.
  • If the RBI cuts CRR, banks will be left with more money to lend or invest. On the other hand, if the CRR is raised, banks will have lesser money to lend.
  • RBI uses CRR to absorb excess liquidity or to release funds needed for economic growth. The present CRR is 4%.
  • When a bank’s deposits increase by ₹100, and if the CRR is 4%, the banks will have to park ₹4 with the RBI. The bank can use only ₹96 for investments and lending purposes.

 

  1. Statutory Liquidity Ratio (SLR)
  • Banks also have to invest a certain portion of their deposits in government securities with the RBI. This percentage is known as SLR.
  • Banks can earn return on these investments. The current SLR is 19.5%.
  • If a deposit of ₹100 is made in a bank, then the bank will have to invest ₹19.5 in government securities.
  • So, to meet CRR and SLR requirements, a bank has to earmark ₹23.5 (4+19.5).

 

 

  1. Repo Rate
  • When banks need money they can borrow from the RBI against their surplus government securities at a fixed interest rate. This rate is known as the repo rate.
  • The higher the repo rate, the higher the cost of short-term money to the banks and vice versa.
  • Generally, whenever the repo rate is raised, banks pass the burden on to customers.
  • If the repo rate is lowered, then banks can potentially charge lower interest rates on the loans taken by borrowers.

 

  1. Reverse Repo Rate
  • The reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods.
  • The reverse repo rate at present is 6%.

 

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